Due Diligence Review: M&A Behind the Scenes - King & Spalding

LEGALduediligence
A Guide for Successful
Due Diligence
BY JOHN KEFFER AND MARK E. THOMPSON
Conducting a thorough due diligence investigation in the
context of an acquisition is more important now than
ever. In an era of shareholder activism, heightened scrutiny
of boards of directors, and ever increasing disclosure obligations,
companies cannot afford to make a mistake in an
acquisition and take on unexpected liabilities. At the same time,
acquisitive companies do not want to lose out on promising
acquisitions by overburdening a potential target with diligence
requests that run the risk of souring the deal. Executives, bankers,
and lawyers must carefully balance these considerations in order
to close a deal successfully. In order to accomplish this goal, a
due diligence investigation must be carefully planned and executed
so that it is conducted efficiently with the least amount of
unnecessary intrusion.
While extremely thorough, in-depth due diligence investigations
have been commonplace in the US for quite some time,
they have become increasingly more common in Europe over the
last several years as well. American companies have been forced
to conduct thorough diligence investigations due, in large part, to
potentially massive litigation, tort, and environmental liabilities.
Not surprisingly, the recent corporate scandals in the US have
resulted in the process becoming even more intensified. It is not
uncommon in the US for the acquiring company to do its best to
know just as much about the target’s liabilities as the target itself.
This concept has begun to spread throughout Europe as well.
This is the result not only of the proliferation of US investment
bankers and lawyers in Europe, but also the recent European corporate
scandals as well as shareholders generally holding managers
more accountable for their acquisition decisions.
The most critical element when planning a due diligence investigation
is for the diligence team to understand the business
objectives behind the acquisition. There is no other single factor
that is more important in determining whether a due diligence
exercise will be a success or a failure. This understanding will
help the team prioritise the investigation and determine what
information is important to review, when it needs to be reviewed,
and, often more importantly, what can be skipped. For example,
it is helpful for the diligence team to understand what business
relationships are important for the target company’s business so
particular attention can be given to contracts relating to that relationship.
Similarly, if certain costs of the target are going to be
eliminated following the transaction due to synergies and redundancies
with the target, any contracts relating to those costs may
only need to be reviewed for termination provisions. It may
involve additional time and expense at the outset to educate the
diligence team as to the goals and objectives of the transaction,
but it will invariably pay off over the course of the transaction.
In connection with understanding the objectives of the transaction,
the diligence team also needs to work with the business
team running the transaction to reach a common understanding as
to the work product they expect the diligence effort to produce.
The final work product produced at the conclusion of a due diligence
exercise can vary widely, and no two are ever identical. On
one end of the spectrum, the diligence team may be asked not to
produce a long, detailed report, but rather only highlight problems
that have been discovered either with the target company
itself or that may be faced during the integration process.
Ironically, this can sometimes be the most difficult type of diligence
assignment as it may result in outside counsel making
almost all the decisions as to materiality independently from their
client. On the other end of the spectrum, some companies prefer
to receive a very detailed report, often hundreds of pages, that
summarises in detail each and every contract. Most investigations
end up somewhere in the middle. Frequently, a summary
memorandum is produced highlighting the significant issues,
while a more detailed backup memorandum is prepared in case
the business people want to drill down on to any particular issue.
Regardless of what kind of report is being produced, however,
understanding the goals and objectives of the transaction, will not
only aid the diligence team in providing a useful work product,
but also allow the team to gather other information during the
investigation that may be asked of them during the transaction
even though it was not part of the scope of the original exercise.
In some acquisitions, the acquiring company not only needs to
conduct a due diligence investigation on the target, but it also
may need to conduct a similar review of itself. This type of self
examination is often overlooked, but can be exceedingly important
not only with respect to synergies, but also potential damages
to the company’s existing operations that may result from the
transaction. For example, in businesses where there are exclu-
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